The risk asset markets are struggling to get a bid this morning after a modest short covering rally to start the week. The underlying problems that have driven oil, equity and most commodity markets lower over the last month or so have not changed. The only change that has occurred is talk of change with no specific outline for a plan to solve the problems. The G8 meeting over the weekend was unanimous that Greece should remain in the EU and some degree of growth strategies need to be incorporated with the austerity programs in place. There was no further details as to how that gets done nor if it is something that will be done in the very short term. The comments were pushed to the European Summit meeting on Wednesday when the market is expecting a more detailed outline as to the approach the EU will take with Greece.

The market interpreted the official communiqué from the G8 meeting as suggestive that the EU may once again bring up the idea of issuing Eurobonds which Germany has been strongly against in the past. I am not certain the German stance has changed very much on this topic and I would be very surprised if that were the outcome of tomorrow's meetings in Europe. Rather I expect some more talk of growth but the majority of the meeting will be dedicated to whether or not to keep Greece in the EU and how to do it. In addition there will likely be discussions on strengthening the firewall around Spanish and Italian banks. I am just not certain the Europeans are going to be able to do their magic trick and kick the can down the road once again or at least convince the market they are in control. These issues have been lingering for over three years and each time they emerge (seems at more frequent intervals) the problems worse than the last time they emerged.

In today's OECD semi- annual economic outlook report the opening says it all about the risks. The global economy is gradually gaining momentum, but the recovery is fragile, extremely uneven across different regions and could be derailed by the crisis in the euro area, according to the OECD's latest Economic Outlook. With slow growth, high unemployment and limited room for maneuver regarding macroeconomic policy space, structural reforms are the short-run remedy to spur growth and boost confidence, OECD Secretary-General Angel Gurría said during the launch of the report in Paris. GDP growth across the OECD is projected to slow from an annual rate of 1.8% in 2011 to 1.6% in 2012, before recovering to 2.2% in 2013, according to the Outlook.

On the eve of a European Union summit in Brussels, the OECD suggested Leaders could stimulate growth by:

  •  comprehensive structural reforms in areas such as education, innovation, competition and green growth.
  •  further enhancing the firewall to prevent contagion of the euro zone financial crisis;
  •  boosting the European single market, to support additional economic activity;
  •  increasing European Investment Bank funding for infrastructure projects;

• making better use of European Central Bank balance sheets.

The OECD warns that failure to act today could lead to a worsening of the European crisis and spillovers beyond the euro area, with serious consequences for the global economy. Avoiding such a scenario requires action to be taken both at country and supranational level.

Yes there will be rounds of short covering but the underlying trend in the oil and the broader risk asset markets is still biased to the bearish side. The markets are going to have to be convinced that the EU has control of the situation and a chaotic exit by Greece from the EU is not going to happen or if it does it is going to be very orderly. The rest of the week will be very volatile and the markets will be trading around the 30 second news snippets that hit the media airwaves from Europe. In addition the upcoming weekend is a long holiday weekend in the US and market participation and liquidity is going to slow down quickly as we get into the second half of the trading week.

The short covering rally extended to most equity markets as shown in the EMI Global Equity Index table below. The EMI Index has recovered about 2% of last week's losses and is now in positive territory for the year by 0.5%. Four of the ten bourses still remain in negative territory for the year with Germany and China still holding the top spots in the Index. As with the rest of the risk asset markets the underlying trend of the global equity markets is still lower. Equities are still a negative price driver for oil and the broader commodity complex based on the fact that the trading pattern is suggestive that the global economy will continue to move in slow motion at best.
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Oil prices are under pressure this morning not only from the turmoil evolving in Europe and elsewhere but the UN's International Atomic Energy Agency has reportedly reached an agreement with Iran on nuclear inspections which is expected to be signed in the next few days. It is another sign that progress is being made in the negotiations and raises the bar of expectations for tomorrow's meeting in Baghdad between Iran and the West. Unless something very surprising emerges from the meeting it is likely to conclude with another meeting of the technocrats scheduled to start to work out the specifics of some sort of deal both sides are comfortable with. It also raises the question that the West might be putting a postponement of an easing of some of the sanctions on the table as part of the negotiations. It could possibly mean a postponement of the EU Iranian oil embargo scheduled to officially begin on July 1. For the moment the geopolitical risk in the Middle East will remain in the background and will continue to be a bearish price driver for the oil complex. But never get lulled into a false sense of security as conditions and negotiations can change in a heartbeat.

This week's oil inventory reports will be released on their normal schedule. The API data will be released on Tuesday afternoon while the EIA data will hit the media airwaves at 10:30 AM EST on Wednesday. At the moment oil prices are still being mostly driven by the direction of the euro and the US dollar as well as by a view that the global economy is continuing to slow. The tensions evolving in the Middle East between Iran and the West have been easing as another meeting will take place tomorrow (see above for more details). As such we expect more market participants to pay attention to this week's round of oil inventory data suggesting that this week's oil inventory reports could also start to impact price direction. This week's oil inventory report could move to being a primary price driver especially if the actual EIA data is noticeably outside of the range of market expectations for the report.
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My projections for this week's inventory reports are summarized in the following table. I am expecting an across the board build in inventories this week with a modest build in crude oil, a modest build in gasoline inventories and a small build in distillate fuel stocks along with an increase in refinery utilization rates. I am expecting a build in gasoline inventories and a build in distillate fuel stocks as the summer planting season is winding down (decreasing the demand for diesel fuel) while the heating oil demand is over. I am expecting crude oil stocks to increase by about 1.0 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 11.7 million barrels while the overhang versus the five year average for the same week will widen to around 28.8 million barrels.

I am also expecting a modest build in crude oil stocks in Cushing, Ok as the Seaway pipeline did not start pumping unit the weekend or after the inventory report period. This would be bullish for the Brent/WTI spread in the short term which is still trading around the $16/bbl premium to Brent level for the last few days. That said I am still of the view that the spread will begin the process of normalization over the next 3 to 6 months.

With refinery runs expected to increase by 0.5% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by about 1.0 million barrels which would result in the gasoline year over year deficit coming in around 4.4 million barrels while the deficit versus the five year average for the same week will come in around 29.4 million barrels.
Distillate fuel is projected to increase by 0.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 20.8 million barrels below last year while the deficit versus the five year average will come in around 13.7 million barrels.

The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year inventories were mixed. As such if the actual data is in line with the projections there will be a modest change in the year over year comparisons for most of the complex.
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I am keeping my view at cautiously bearish after oil broke down on all fronts over the last few weeks but with the possibility for a short covering rally occurring at anytime is increasing. Oil is still solidly below the trading range it was in just a few weeks ago and well below several key support areas. WTI is still solidly trading in double digits with Brent slowly heading in that direction.
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I am keeping my view at neutral and keeping my bias also at bullish with an eye toward the upside. The surplus is still building in inventory versus both last year and the five year average and could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production.

Currently markets are mixed as shown in the following table.
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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.

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